MNI: Fed’s Schmid - Policy Should Keep Pressure On Inflation

Federal Reserve Bank of Kansas City President Jeff Schmid said Wednesday interest rates should stay at a level where they continue to put some pressure on the economy so that inflation can cool further, while also advocating further efforts to shrink the central bank's balance sheet. 

"With demand outpacing supply and inflation running closer to 3% than 2%, I see it as appropriate to maintain a somewhat restrictive policy stance," he said in prepared remarks. "Restrictive monetary policy can help slow demand growth, giving supply time to catch up and alleviate inflationary pressures."

"With growth showing momentum and inflation still hot, I’m not seeing many indications of economic restraint," Schmid added. 

"In my view, further rate cuts risk allowing high inflation to persist even longer," he said. "A price shock is ultimately transitory on account of the Fed’s actions, and not some internal dynamic independent of the central bank. We must remain focused on our headline inflation objective, otherwise I believe there is a real risk that inflation will get stuck closer to 3% than 2% in the long run."

RESERVE DEMAND

Schmid also said it is critical to ensure that the Federal Reserve reduces its footprint in financial markets, tying the central bank's actions around its balance sheet to central bank independence. "The more the lines between monetary and fiscal policy become blurred, the greater risk that the Fed’s balance sheet is no longer viewed as solely a tool of monetary policy."

"I think reducing the footprint of our balance sheet matters within the context of Fed independence. By independence, I mean the ability to set interest rates in pursuit of our dual-mandate objectives without political considerations. History has shown that a central bank focusing solely on its mandates delivers better economic outcomes." 

While reserve demand is surprisingly high now, there are opportunities to reduce reserve demand over time, especially as the regulatory environment and payments technologies continue to evolve, he said. "Guiding towards a lower level of reserves is not only feasible in my opinion, but something that should be pursued to allow for a smaller balance sheet." (See: MNI: Warsh Wants Fed Out Of U.S. Treasury's Business) 

Second, though the Fed is currently again growing the balance sheet for liquidity purposes, it can continue to reduce its footprint in other ways. "We continue to wind down our mortgage portfolio, and we have started to reduce the maturity of our Treasury holdings," Schmid said in a speech in New Mexico.